S&P Poised to the Upside; Dollar Should Maintain Strengthening Trend

Includes: SPY, UDN, UUP
by: The LFB

The S&P seems poised to make a move to the upside, despite the on-going credit crisis and assessments from the GSE (Government Sponsored Entities) that the housing market will continue to be weak.

Depending on whose figures you wish to use, total credit related losses will be in the $1 trillion (NYSE:IMF) to $2 trillion (Nouriel Roubini) range but, more importantly, as far as the market is concerned, these figures imply that total losses are a “known entity” , which allows for the market’s forward discounting mechanism to proceed. Participants may also be looking at the Treasury’s plan to backstop the GSE as representing a “bottom” or, as we prefer, “turning point” within the overall negative cycle dated from the peak on October 11.

From the standpoint of currencies and commodities (the inverse correlation of EUR/USD and oil), the Federal Reserve is now apparently on hold (which generally is a positive for equities) through January 2009 since they will be operating their special lending facilities at least until then, and because of the Fed’s projection (from the last statement) that inflation will “moderate.”  Meanwhile, the ECB is on hold through the September meeting, when it will present its new growth and inflation projections. 

The dollar should be able to maintain a general strengthening trend on the basis of apparent central bank policy, and therefore oil should be able to remain in a downward trend, aided by the market’s belief in the “demand destruction” concept based on a perceived slowdown of global growth (with the risks here being related to supply issues and/or geo-political tensions).

From a technical view several factors weigh towards a continued appreciation of the S&P. Using the October 11 high for the S&P (1576.01), we note that Thursday’s closing price (on a 1.58% decline for the day) allowed the index to close above “official” bear market territory (19.66% loss to there), and after Friday’s close the index is sitting on a 17.75% decline from the October 11 peak. Since the low on July 15, the index has made a series of higher lows. Using Fibonacci extensions to measure the retracement from the last decline (May to July), we see the resistance, which held at the .382 extension (1292), has now been surpassed on Friday’s close.

What’s even more interesting is when you use Fibonacci from the Oct 11 peak; from that point, price has surpassed the resistance at the .236 extension. We also like the way that price and volume moved on Friday, especially in the last hour of trading. Price finished very close to the highs of the day as volume increased 44.55% from the previous hour, second only to the normally busiest first hour. The ratio of up to down volume was 3.48/1 in the last hour as compared to the first hour’s 2.14/1, a 63% improvement, and the ratio increased 18.3% in the last hour compared to the previous one.